China might collapse

Contrary to the common narrative of China’s rise to threaten the West, we should consider the nonzero probability of Chinese collapse

Tl;dr

·      Current Chinese-American tensions have their roots immediately after WW2 over the status of Taiwan

·      What happens in China affects the day-to-day lives of Americans

·      While not the most likely scenario, China has several areas of structural weakness that could lead to its collapse

·      Specifically, China’s governing system is fragile, it faces financial crisis, its population is imploding, it has limited domestic energy, and it is the historical norm for different factions to compete to rule the country

·      To mitigate the risk of collapse, the US should reshore critical supply chains, the US Navy should prepare contingency humanitarian relief plans, and US Special Forces should prepare to rapidly secure Chinese nuclear weapons should Beijing lose control

Figure 1: Pro-democracy protester in Tiananmen Square, China (1989)

Fourth Taiwan Straits Crisis

Much is being made in the media around Speaker of the House Nancy Pelosi (D-CA) and her visit to Taiwan. At second in line for the US Presidency, she is the highest-ranking US official to visit the island-nation since 1997. The controversy has become a major US political issue, with President Joe Biden saying the military didn’t think the trip “is a good idea”. Meanwhile, a bipartisan group of Democratic and Republican lawmakers have put aside their differences and back the trip, saying that China cannot dictate where American officials travel. The Chinese government vocally opposed the visit and one Chinese tabloid journalist even threatened shooting down her plane (a rather extreme position falsely attributed to the Chinese government).

Figure 2: House Speaker Nancy Pelosi (D-CA) in Taiwan, August 3, 2022

Background to the issue

Understanding why Taiwan is such a hot-button issue between the US and China requires going back the aftermath of WW2, when the current global security order was created, to the Chinese Civil War (1945-1949). Nationalist forces under General Chiang Kai-shek (supported by the US) were driven from mainland China by Communist forces under Mao Zedong to the island now called Taiwan. The Nationalists set up the Republic of China on the island, not to be confused with the People’s Republic of China set up on the mainland by Chinese Communist Party (CCP) under Chairmen Mao. To the present, the official name for Taiwan is the Republic of China and since a peace treaty was never signed, the civil war is technically ongoing.

Figure 3: Map of mainland China and Taiwan

The US backing the losing side (the Nationalists) became a major domestic political liability for Democratic President Harry Truman and a problem in international diplomacy. Since both the CCP and the Nationalists claimed to be the sole legitimate government for all of China (typically a country only has one government), the international community faced a dilemma over who to recognize as the official government of China. Eventually, most of the world began to diplomatically recognize the CCP in the 1970s, and finally the US in 1979. But there was still the issue for the US that Taiwan very much existed, and the People’s Republic of China under the CCP did not want them to exist. To reconcile this, the US came up with the imaginative “One China Policy”, which "acknowledges that all Chinese on either side of the Taiwan Strait maintain there is but one China and that Taiwan is a part of China" and "does not challenge that position”. The US wants a peaceful resolution to the Taiwan issue, has unofficial relations with Taiwan, and the “One China Policy” is still US policy today.

But of course, this is all diplomat speak for an issue that is very much unresolved. The US remains officially ambiguous about whether it would use military force to protect Taiwan from a mainland invasion, but regularly patrols the area with its navy. It’s sort of a “I’m not going to say what I’ll do, but my battleship says I’ll defend Taiwan”-type situation. It gets trickier in that declining to defend Taiwan would signal to other countries around the world with US security guarantees that those guarantees are not credible. It would undermine the post-WW2 global security order, which has been the glue holding the world together for the past unprecedentedly peaceful and prosperous seventy-five years. The issue has come to a head before, during the First and Second Taiwan Strait Crises under US President Eisenhower and Third Taiwan Strait Crisis under President Bill Clinton. Which brings us to today, where a visit to Taiwan by Nancy Pelosi could provoke a Fourth Taiwan Strait Crisis. Due to the strategic importance of Taiwan to both the US and China, it is one of the handful of flashpoints on the planet that could escalate to a nuclear exchange.

Why can’t we just get along?

You’re probably thinking it’d be an awful shame to get into a nuclear war over diplomatic protocol. And that would be the thinking of a reasonable human being. But international relations can be unreasonable. Consider the following thought experiment. What’s keeping you from breaking into your neighbor’s house and stealing their things? Beyond morals, doing so would lead to your neighbor calling the police and your being arrested. A system of law and order is part of the contract we’ve made with our government to keep society operating smoothly. But between nations, who’s the police? Only raw power matters in relations between nations. Supra-national organization like the United Nations provide the illusion of rules, but behind the scenes only power matters.

At the international level, relations most closely resemble jail yard anarchy, where the strongest inmates come out on top. That is why the US finds itself at odds with China, unarguably one of the greatest civilizations in the history of the world. I don’t know if current events will trigger the Fourth Taiwan Strait Crisis. But I do think that Chinese bluster about the visit signals weakness and allows them to divert attention from their many problems. And while I’m not predicting the collapse of China, it is a scenario we should consider, along with its effects on the US.

Why this matters to us

You may be wondering how this applies to the US (beyond the small chance of nuclear war) and why it’s being covered on a Substack about the American economy. The sheer size of China’s economy and population means that changes there have a big impact on the US.

In the middle of the 2000s, when the Iraq War was dominating the media in the US, China was rapidly urbanizing and growing its economy. Millions were moving from the countryside to the cities in the largest migration in human history. Industrialization on this scale was sucking raw materials like crude oil and iron ore into China and spiking prices globally in what was called a “commodity supercycle”. After a brief interruption when the global financial system imploded in 2008, crude oil reached almost six times its 1996 price. Collapse in China would have the opposite, rapid effect.

Figure 4: Prices during the "commodity supercycle"[i]

We also buy a lot of stuff from China and are continuing to buy more. Our bilateral trade deficit (what we export to China less what we import) grew to $676 billion in 2021[ii], the highest ever.

Figure 5: US trade deficit with China[iii]

We also found out during COVID-19 that China makes many of our essential medical PPE and pharmaceuticals. After the initial shortages, a collapse in China would be massively inflationary for the goods we buy.

Americans have a peculiar psychology when it comes to our global enemies that clouds our judgement. We were in an existential battle with the Soviet Union…until it unexpectedly collapsed. In the 1980s, we feared a coming war with Japan (this book didn’t age well). There are several indications of China’s weakness, and their saber rattling around Nancy Pelosi’s visit to Taiwan confirms this.

The fragility of autocracy and the resilience of democracy

An autocracy is when one leader calls the shots, a dictator. This can allow an autocracy to move quickly in a fast-changing world and do incredible things. But when the dictator gets a decision wrong, there is no feedback mechanism and things can fail spectacularly. An autocracy is fragile and over a long enough time horizon is doomed.

In a democracy, there is lots of messy debate and things move slowly (sometimes frustratingly so). There are many checks and balances, and depending on the system, state or regional governments to counter the central government’s power. Periodic elections hold leaders accountable and serve as a feedback mechanism. Although it may get a slow start, a democracy is resilient over the long-term.

Under the Ming Dynasty in China (14th-17th century AD), the emperor banned maritime trade.[iv] As a result, China turned inward and missed everything happening in Western Europe (the Renaissance, the Enlightenment, and the Industrial Revolution). The West and the East diverged, and the process of catch-up continues to this day.

Today’s dynasty is the CCP and the emperor is Xi Jinping. There are many decisions that could go wrong, but the “zero COVID” policy is especially risky. ”Zero COVID” allegedly comes directly from Xi Jinping and compensates for the lack of effective Chinese vaccines and herd immunity by imposing strict lockdowns on millions if even a single case is detected. Lockdowns have become more frequent, especially as more contagious variants have emerged. Economic avidity has slowed as important areas like Shanghai go under lockdown.

The CCP has made a tacit deal with the Chinese people: one-party rule in exchange for spectacular economic growth and poverty reduction. Economic growth has been decreasing, and is forecast to continue declining.

Figure 6: Chinese GDP growth[v]

The “zero COVID” policy could accelerate that decline and after the growth stops, the Chinese people may grow tired of one-party rule.

The Chinese Real Estate Bubble

Another threat to Chinese economic growth and CCP legitimacy is the unsustainable growth of private debt in China, mostly to fund real estate. Housing construction is a great way to fuel economic growth. Building a house employs a crew of workers, a housing development creates demand for shops and restaurants, and a home mortgage is a stream of fees for a bank (which will turn around and create more credit to repeat the process). And when you have millions moving from the countryside to the cities, you need a lot of new homes. The result is an explosion in private credit.

Figure 7: Growth in Chinese private credit compared to other countries[vi]

But when real estate prices decline, as they have begun to over the last several months, people stop being able to pay their mortgages and the whole system implodes (like the 2008 subprime mortgage crisis in the US, but on a bigger scale).

That scenario is only one way this bubble bursts. Another occurs when Chinese property developers are unable to pay their debts (like this one) and cease operations. In China, people sometimes begin paying their mortgages before they get their home from the developer. Reports have emerged from Chinese social media that people waiting on stalled housing from insolvent developers have stopped paying their mortgages in protest. The result was tanks in the streets. This video is said to be a routine military exercise by the CCP, but some aren’t buying that story.

Wall Street Silver @WallStreetSilv

🚨🚨🚨🚨Breaking news🚨🚨🚨🚨 Tanks are being put on the streets in China to protect the banks. This is because the Henan branch of the Bank of China declaring that people's savings in their branch are now 'investment products' and can't be withdrawn. 🔊sound

Demographic Implosion

Much of the last post on this Substack was dedicated to how important demographics are to economic growth. Thanks to the One Child Policy, China has some of the worst demography on the planet. China’s population peaked this year and has begun to decline. Most forecasts show them around 1 billion in 2100, from 1.4 billion today. The most extreme forecasts project 600 million in 2100, less than half the population of today.

Figure 8: Population decline in China[vii]

To date, China’s biggest advantage is plentiful, cheap labor. But as China modernized, that advantage has gone away and labor costs have skyrocketed. Today, labor costs are cheaper in Mexico and much of SE Asia. A collapsing population will accelerate this trend.

China has very little oil

As much as we’d like a post-petroleum economy, we’re still decades away from that goal. Export-led manufacturing economies in particular like China use a lot of oil, mostly as a transportation fuel. At 14.5 million barrels per day (mbpd), China is the world’s second largest oil consumer (the US uses 20.5 mbpd, for comparison)[viii]. Of that China only produces 4.9 mbpd (34%) domestically, and imports the rest.[ix]

Of the imports, most come by sea from the Middle East through a pinch point called the Strait of Malacca (off Singapore). If that flow is interrupted (which could be achieved by multiple navies on the planet) the wheels of China’s economy will cease.

Figure 9: Chinese oil imports[x]

History of fragmentation

Finally, China has been a global superpower for thousands of years, but is periodically not unified under a single government. The CCP is only the latest dynasty to consolidate power in the country. The current regime came to power in 1949, but previous periods of disunity include the Chinese Civil War, the Boxer Rebellion, the Taiping Rebellion, and the Waring States Period. The historical norm is for the Chinese mainland to be periodically disunified. Below is a timeline showing how often the mainland has been fragmented or switches ruling dynasties.

Figure 10: History of rulers in China[xi]

Action plan

I am in complete agreement with the hardline bipartisan consensus to compete with and confront China. That means continuing to make American manufacturing globally competitive, investing in Indo-Pacific military capabilities, and strengthening alliances in the region.

Additionally, we should make contingency plans for the unlikely but possible scenario of Chinese collapse.

1.     Reshore critical supply chains

2.     Develop plans for major humanitarian operations in the region

3.     Develop plans to rapidly secure Chinese nuclear materials

One of the first acts of the Biden Administration upon taking office was issuing an executive order calling for a 100-day review of America’s critical supply chains. That report was issued in June 2021 and found that semiconductor and some medical supply chains, among others, needed to be reshored. Congress just passed the CHIPS Act on bipartisan lines to bring semiconductor fabrication back to the US. We should do the same with other critical supply chains.

As many as 55 million died from famine in China during the The Great Leap Forward, the CCP’s second Five Year Plan (1958). It was the greatest famine in human history. China is much bigger today, and a collapse could interrupt agricultural supply chains. The situation could be a major human tragedy. The US Navy should develop plans for a large-scale humanitarian relief operation that delivers food to China’s coastal cities and then into the countryside.

When the Soviet Union collapsed, one of the biggest concerns was nuclear proliferation. China has around 200 nuclear warheads and is expected to have 1000 by 2030. If the Chinese command and control system breaks down in a collapse, a single warhead falling into the hands of a rogue general or terrorist organization could cause major trouble for the world. US Special Forces should develop plans to rapidly secure China’s nuclear weapons in the event Beijing loses control.

It’s a race

There is no doubt that China’s current economic trajectory is unsustainable. The question is, can they use the wealth they are creating to buy stability? The answer to that question will define the 21st Century.

Figure 11: Wile E. Coyote gets ahead of himself

China understands these weaknesses and is working to address them. It knows that it is approaching rocky waters, which is why strongman Xi Jinping is widely expected to secure an unprecedented third term this fall. Dictators can do unpopular, but necessary things.

I don’t think Chinese collapse is the most likely scenario but it’s definitely possible. If I were to bet, I think stagnation and closer ties with Russia are more likely. But that doesn’t make the Taiwan Strait or the South China Sea any less dangerous. If anything, instability increases the danger. I think 2023 or 2024 (when both Taiwan and the US have Presidential elections) is probably the point of maximum danger.

Xi Jinping promised his people the “Chinese dream”, which meant economic growth and a better life. But if he isn’t careful, that dream could turn into a nightmare.

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[i] The Economist

[ii] US Commerce Dept

[iii] HBR

[iv] Kissinger, Henry. On China. Penguin, 2012. 

[v] IMF

[vi] Zeihan, Peter. The End of the World Is Just the Beginning: Mapping the Collapse of Globalization. Harper Business, 2022.

[vii] New York Times

[viii] EIA

[ix] EIA

[x] EIA

[xi] www.chinahilights.com